THE NEW 990 AND ITS RELATIONSHIP TO CALIFORNIA LAW

For the 2008 tax year, the Internal Revenue Service has revised IRS Forms 990 and 990-EZ, its informational returns for nonprofit organizations. The forms ask for new information that will allow the IRS to better assess a nonprofit’s tax-exempt status. While that is a good thing, the forms and the instructions for them may mislead charities concerning independent state regulatory requirements, which are far more comprehensive and detailed than federal standards for maintenance of tax-exempt status. Set forth below is a description of the IRS changes that should prompt a charity that is organized or doing business in California to review California law governing the subject of those changes.

The new 990 includes questions about an organization’s governance structure, policies, and practices, as well as additional schedules that call for information concerning the internal and external operations of the charity. For hospitals, there is a new schedule (optional for 2008) that asks questions about charity care, community benefits, community-building activities, manner of accounting for bad debt and Medicare, and debt-collection practices.

Fewer changes have been made to the 990-EZ, the short-form version of the 990 for smaller organizations, but some of the same new schedules added to the 990 are incorporated in the new 990-EZ. Also, the IRS has raised the dollar thresholds for gross receipts and total assets below which it is permissible to file the 990-EZ rather than the 990. These changes relate to many matters that are also the subject of specific provisions of California law. This overlap suggests a need to review these independent state regulatory standards so that charities are not misled by the new 990 reporting requirements concerning their obligations under state law. State law applicable to charities often relates to matters that are not subject to a specific IRS standard for maintenance of tax-exempt status. And where such federal law does exist, state law may in some cases set a stricter standard.

The IRS instructions for the new Part VI of the 990, entitled “Governance, Management, and Disclosure,” offer an example of the potential for confusion. At the outset, the instructions make clear that, although the information sought is not required under the Internal Revenue Code, the IRS believes the questions have a bearing on continued entitlement to tax-exempt status:

Even though governance, management, and disclosure policies and procedures generally are not required under the Internal Revenue Code, the IRS considers such policies and procedures generally to improve tax compliance. The absence of appropriate policies and procedures may lead to opportunities for excess benefit transactions, inurement, operation for non-exempt purposes, or other activities inconsistent with exempt status. (Emphasis in original.)

The IRS instructions then include, however, the following statement, which could be interpreted as allowing a charity discretion concerning how it conducts its operations—a discretion that may not exist, given specific provisions of applicable state law:

Whether a particular policy, procedure, or practice should be adopted by an organization may depend upon the organization’s size, type, and culture. Accordingly, it is important that each organization consider the governance policies and practices that are most appropriate for that organization in assuring sound operations and compliance with the tax law.

While this suggestion that a charity has wide discretion to choose among governance alternatives may be consistent with the IRS’s recognition of a lack of prescribed standards at the federal level, that discretion may not exist under applicable state law. State law may remove any discretion by imposing governance obligations applicable across the board to all charities. Or state law may prescribe obligations that are applicable to charities at certain revenue and asset levels, but not at others. In both cases, a discretion that might otherwise be allowed under federal law has been displaced by a specific state regulatory provision.

In California, the Attorney General oversees charities. The authority proceeds from the common law as well as various California statutes, including the Supervision of Trustees and Fundraisers for Charitable Purposes Act (Gov. Code, §§ 12580-12599.7), the Nonprofit Corporation Law (Corp. Code, §§ 5500-10841), and the Unfair Competition Law (Bus. & Prof. Code, §§ 17200-17210, 17500-17582). The Attorney General’s oversight authority is implemented in regulations that are set forth in title 11 of the California Code of Regulations.

This body of state law differs in some respects from federal tax law applicable to charities. More broadly, it establishes standards of conduct for charities that, as the IRS 990 instructions recognize, are “not required under the Internal Revenue Code.”

For charities incorporated or doing business in California, various lines and schedules of the new 990 can serve as a helpful checklist of charity governance issues that are of concern to both the federal and state governments. More important, they should call to mind specific standards that, while absent from federal tax law, must be followed by California charities. Set forth below are the requirements of California law that relate to the information called for by the new 990. Also set forth are the differing federal and state requirements for financial reporting.

The difference in financial thresholds for filing reports

The IRS requires that a nonprofit organization file some version of the 990 if its gross receipts are over $50,000. If gross receipts are $50,000 or below, only IRS Form 990-N (e-Postcard) need be filed.

The California Attorney General has different filing requirements for charities. Every year, all California charities, regardless of gross revenue or total assets, must file Form RRF-1, the Annual Registration Renewal Fee Report. And because the Attorney General uses the 990 as one of the reporting tools for charities, a charity may sometimes be required to file a 990 with the Attorney General even when there is no requirement that a 990 be filed with the IRS. For instance, a California public benefit corporation that is not exempt from tax under federal law must nonetheless file with the Attorney General an IRS Form 990, 990-EZ, or 990PF, as applicable, if either its annual gross revenue or its gross assets, at all times during its fiscal year, are $50,000 or more. And even if it is below those income and asset thresholds, a California charity must file a 990 with the Attorney General in the following situations:

it has not filed a Form 990 for 10 years;

the corporation or unincorporated association was dissolved or merged, the trust was terminated or modified, all or substantially all of the assets of the corporation or trust were sold or transferred, or the corporate articles were amended to change the charitable purposes of the corporation;

the charitable purposes of the corporation, unincorporated association, or trust were abandoned by the directors or trustees;

there were any self-dealing transactions, as defined in California Corporations Code section 5233, or any transactions described in Probate Code section 16004, or any loans made by the corporation or trust to a director, officer or trustee.

What California charities should think about when filling out Part VI of the IRS Form 990 (Governance, Management, and Disclosure)

Section A (Governing Body and Management)

Line 1a (number of voting members of governing body)

Corporations Code section 5210 provides that, subject to exceptions in the code and the articles or bylaws, all corporate powers shall be exercised by or under the ultimate direction of the board of directors. Corporations Code section 5213 provides that a corporation shall have, at a minimum, a president or chairman of the board, a secretary, and a chief financial officer, and that neither the secretary nor the chief financial officer may serve concurrently as president or chairman of the board.

Line 1b (number of voting members that are independent)

Corporations Code section 5227 provides that not more than 49 percent of persons serving on the board of directors may be interested persons. “Interested person” includes (1) any person currently being compensated by the corporation for services rendered to the corporation within the 12 previous months, excluding reasonable compensation paid to a director as a director, and (2) any one of a defined range of relatives of such a person.

Line 2 (whether officers, directors, trustees, or key employees had a family or business relationship with another such person)

Line 3 (delegation of management duties)

Corporations Code sections 5210, 5212, and 5231, taken together, provide for delegation of the powers of the board of directors to committees or other persons, subject to certain limitations, and prescribe a standard of care.

Line 4 (significant changes to organizational documents)

Corporations Code sections 5810-5820 prescribe permissible amendments to the articles of incorporation and the manner of making them.

Lines 6-7 (organizations with members and the powers of members)

Corporations Code sections 5310-5354 pertain to nonprofit corporations that have members and provide for the rights and obligations of members and the issuance, types, transfer, and termination of memberships.

Line 8 (documentation of meetings of governing body and committees with authority to act for governing body)

Corporations Code sections 5212 and 6320 provide for notice of and conduct of board meetings and the keeping of minutes of board and committee meetings.

Line 10 (approval of Form 990 by the governing body)

Corporations Code section 5231 prescribes the standard of care and liability of directors.

Section B (Policies)

Line 12a (conflict of interest policy)

Corporations Code sections 5231, 5233, 5236, and 5237 govern the standard of care for directors, self-dealing transactions, loans or guaranties for an obligation of a director or officer, and liability of directors.

Line 15 (determination of compensation for officers and key employees) (Also see Part VII and Schedule J of IRS Form 990)

Corporations Code section 5235 provides that executive compensation must be just and reasonable and prescribes liability for excessive compensation.

Government Code section 12586 requires review and approval by the board, an authorized committee of the board, or the trustee or trustees of a charitable trust, of the compensation, including benefits, of the president or chief executive officer and the treasurer or chief financial officer to ensure that it is just and reasonable. This review and approval must take place upon hiring, whenever the term of employment of the officer is renewed or extended, and whenever the officer’s compensation is modified.

Section C (Disclosure)

Line 18 (manner of making IRS Forms 1023 and 990 available for inspection)

Government Code section 12586 requires that a charity’s audited financial statements be made available for public inspection.

Part VII of the IRS Form 990 (Compensation)

See reference to Corporations Code section 5235 and Government Code section 12586 above, regarding line 15 of Part VI.

Various provisions of the Corporations Code require notice to or approval of the Attorney General regarding a wide range of transactions, including those identified in Schedule N of IRS Form 990. See sections 999.1-999.5 of title 11 of the California Code of Regulations, together with the sections of the Corporations Code referenced in the regulations.

For information about regulatory requirements applicable to California charities, including laws and regulations, forms, instructions, guidance, and frequently asked questions, please visit the Attorney General’s website at oag.ca.gov/charities and review the Guide for Charities, which is available on the website.